Summer of ‘sturm und drang' to keep gold on positive path
Economic and political instability looks to be the dominant factor this northern summer and the odds favor gold price volatility with sharply rising price rises a likely outcome.
Posted: Tuesday , 21 Jun 2011
NEW YORK -
The days and weeks ahead could be tumultuous for gold with the yellow metal's price primed to move one way or the other depending on news from European finance ministers, the European Central Bank, the Greek Parliament and, last but not least, the Fed's FOMC policy-setting committee and Chairman Bernanke's news conference later this week.
Technically, gold remains range bound with good support, as we saw last week, between $1515-$1522 and overhead resistance in the $1545-$1555 range. A break out in either direction, perhaps triggered by news of a more fundamental nature, could signal a bigger move. Should prices fall, we would view this as a "scale-down" buying opportunity.
Eurozone finance ministers meeting over the past week-end once again could not agree on a bail-out package for functionally bankrupt Greece, which runs out of cash to pay its debts in the next few weeks . . . and even if they could agree the European Central Bank (ECB) threatens to declare a Greek default if private lenders don't share the burden with Greece's public-sector creditors.
The chief risk is that a number of major French and German banks would have to mark down the value of Greek debt on their books, leaving them undercapitalized and in need of recapitalization by the ECB to remain solvent. Moreover, as credit ratings decline for all of the peripheral countries, their rising interest costs to refinance maturing debt make it all that much more difficult to keep their heads above water.
Quite possibly the Greek parliament in a vote of confidence this week for Prime Minister Papandreou will accept more austerity measures as part of the deal to win Eurozone funding . . . but even this "favorable" outcome will only provoke more rioting in the streets of Athens by public-sector workers unwilling to accept more of the burden of adjustment and a further erosion in their living standards.
Chances are the Eurozone finance ministers and European Central Bank will find a way to postpone the hard decisions that will ultimately end Europe's failed experiment with a single currency. But, sooner or later, whatever happens, it is difficult to imagine a scenario in which gold does not emerge the winner, even if the immediate short-run reaction is a sell-off in gold, as we have seen at the start of past financial panics (think Lehman Brothers) as investors seek the liquidity of cash.
EYES ON THE FED
Meanwhile, U.S. and world stock markets are now undeniably in a downtrend if not a full-blown bear market . . . and incoming economic indicators are pointing to a second phase in what is quickly becoming a double-dip recession.
So far, most Washington politicos and Wall Street bankers are in denial, refusing to see the worsening signs of renewed recession. Instead, they are arguing for restrictive economic policies that, if enacted, would exacerbate the developing downturn . . . and which the history books would liken to the policy mistakes of the 1930.
The Fed also fails to see, at least publicly, the writing on the wall - and is preparing to end its program of monetary easing through the purchase of government bonds, a program that both creates new money in an attempt to liquefy the economy and finances the Federal debt at low interest rates without having to go hat in hand to our foreign creditors.
All eyes and ears in the gold and world financial markets will be focused later this week on the June FOMC meeting and Chairman Bernanke's press conference for the Fed's assessment of the economy, inflation and employment prospects, and any hints of forthcoming adjustments to Fed policy.
If the Fed, indeed, ends its program of quantitative easing at month-end as scheduled, it will - in my view - soon be forced by rising unemployment and sluggish business activity to resume monetary stimulus in one form or another. Perhaps not QE3 - a further round of quantitative easing might be difficult to swallow - but a rose of some other name.
We think the only viable and politically acceptable means for America to dig itself out of its unbearable burden of excess debt - federal, state and local, housing, and other private-sector debt - is to pursue a policy of higher inflation that will deflate the ratio of outstanding debt to nominal gross domestic product (GDP) to historically acceptable and manageable levels. Indeed, under Chairman Bernanke's lead, the Fed is already quietly pursuing this policy of targeting somewhat higher U.S. price inflation.
Pursuit of a mildly inflationary monetary policy will not however excuse Congress and the Administration from developing a responsible believable program of long-term spending restraint and deficit reduction. However, now is not yet the time to impose these restrictions on an ailing economy - though articulation of a realistic bi-partisan plan for long-run deficit and debt reduction would help calm world financial and currency markets.
Adjusted for consumer price inflation, using official government data (data that tends to seriously underreport actual inflation felt by American households), suggests that gold should be selling today for at least $2500 an ounce . . . and considerably more if we were to account for the government's underreporting of actual inflation.
Europe's troubles and the collapse of the euro as we now know it will make the dollar look good by comparison . . . and a rising dollar against the euro could briefly dent gold as traders fall back of the historical inverse relationship between gold and the U.S. dollar exchange rate vis-a-vis competing currencies in world foreign exchange markets.
But a rising dollar would be nothing more than a "paper tiger" soon to be deflated by America's budget mess, sagging economy, and renewed U.S. monetary stimulus. As noted at the outset of this brief essay, a setback for gold should be greeted by investors as another buying opportunity as it surely would by those central banks wishing to build gold holdings without disruptively sending gold prices higher.
HOT SUMMER AHEAD
Most gold pundits are anticipating a traditionally quiet summer of the yellow metal. Historically, gold prices have exhibited strong seasonality - with relative weakness in the Northern Hemisphere summer months and maximum relative strength late in the calendar year. To a large extent, this seasonal pattern has been a reflection of culturally determined buying habits in the major gold-consuming countries and regions.
For example, India - often the biggest gold-consuming nation - usually enjoys a pick up in gold buying in September when harvests boost income and spending in the agrarian sector, a sector with a high propensity to buy gold for jewelry or saving with any excess income that comes their way. Around the same time begins a string of festivals that continue into May, festivals that are propitious for marriage, hence requiring gold dowries. These festivals are also believed by many Indians to be a lucky time to buy gold as an investment.
Also in September, in the United States and other Western nations, jewelry manufacturers begin stocking up and fabricating gold jewelry for the December Christmas gift-giving season followed closely by the February 14th Valentine's day, which is also accompanied by much gold jewelry gifting.
Around the same time, the Chinese or Lunar New Year occurring in January or February heralds in a period of gold demand for jewelry fabrication and gift giving across Greater China . . . and is also seen by many as a propitious time for gold investment.
But these seasonal factors are diminishing - largely because investment demand, which knows no season, is growing rapidly in importance and, to some extent, displacing jewelry demand. First, there is the expansion of secular, long-term, hoarding demand for gold reflecting the growth in incomes in Greater China and India. As incomes rise, so does demand for gold jewelry and investment bars, in these countries - which increasingly occurs independently of seasonal, festival, marriage, or gift-giving considerations.
In many countries, too, we are seeing an increase in official or central bank buying: In recent years the list of gold buyers has included China, India, Russia, and a host of other countries for whom seasonality plays no role whatsoever in the decision to accumulate gold reserves and diversify away from the U.S. dollar.
And, importantly, powerful economic and geopolitical forces that also exhibit no seasonality are now increasingly governing short-term investment and speculative trading demand for gold. The extent to which the typical summer "doldrums" for gold will be overwhelmed by unfolding economic and political events remains to be seen.
But, clearly, gold-price direction and volatility will be affected in the weeks and months ahead by the economic developments discussed above, namely U.S. monetary and federal budget policies as well as Europe's sovereign debt crisis and the coming disintegration of region's common currency.
Moreover, what we haven't talked about is the potential for events across North Africa and the Middle East to trigger a rush into gold - should instability spread to Iran and/or Saudi Arabia; should Afghanistan or Iraq deteriorate into all-out civil war; should democratic reform in Egypt or Tunisia be replaced with new tyrants less friendly to the West; should regime change in Libya, Syria, or Yemen herald in worse; or should oil supplies and prices become less secure.
Clearly, events in this region are not proceeding as first imagined by Western powers.
So, it remains to be seen if the coming summer will be a period of calm and relative stability for gold . . . or a period of great "sturm und drang" with sharply rising prices and greater volatility. Odds favor the latter.
Whatever the immediate future holds in store, we remain firmly committed to our bullish gold-price forecast with the metal trading at or close to $1700 later this year with still higher prices in the years ahead.
Jeffrey Nichols, Managing Director of American Precious Metals Advisors, has been a leading gold and precious metals economist for over 25 years. The above article is a lightly edited version of one published on www.nicholsongold.com